(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, April 1 (Reuters) - Oh dear!
Just when the London Metal Exchange (LME) was poised to fire its "bazooka" at the long-running problem of warehouse queues, along comes Justice Phillips with an order to put the safety-catch back on.
The British High Court judge found the LME's consultation on forcing its warehouse operators to link load-in and load-out rates was "legally unfair".
This being a legal rather than market-based judgment, the devil is inevitably in the legal detail, specifically the LME's failure to explain fully the reasons for not considering the alternative option of capping or rebating the amount of rent payable on metal sitting in a load-out queue.
The fact that the LME has received consistent advice that to do so would fall foul of EU competition law is not the point.
"Given its status as (apparently) the next obvious option referred to (...) in the second paragraph of the Consultation Notice, some explanation of the option, the result of the recommended discussions and the reason why the option had been discounted was necessary for a proper understanding of the LME's thinking in relation to the Proposal," was Phillips' assessment.
So what happens now?
The "bazooka" remains loaded. It may yet be fired but the timing will depend on whether the LME decides to appeal the ruling or instigate a new consultation.
And despite what is undoubtedly a public-relations disaster for the LME, the exchange still has plenty of other tools to tackle its warehousing woes.
But the truth of the matter is that there are no winners here, just losers.
Even the victor of the High Court case, Rusal, has little to crow about.
The very fact that it was prepared to take legal action against the LME is a sign of desperation.
This is a company that has just recorded a $3.2 billion loss for 2013 and is teetering on the brink of a loan default.
Rusal has belatedly joined the race to reduce costs by shuttering less efficient aluminium smelting capacity, following in the footsteps of U.S. peer Alcoa, which has just announced another 147,000 tonnes of curtailments in Brazil.
Both, though, are still dependent on the physical premium component of the aluminium price to make any money at all. The LME price averaged $1,845 per tonne last year. Rusal's average cost of production was $1,907 per tonne. Alcoa's was $2,201.
It was fear of losing the all-important premium that caused both producers to attack what they described as the LME's intervention in the aluminium market.
Rusal went further by taking legal action but then without Alcoa's value-added downstream business, it is more exposed to the price of commodity metal.
The core problem for all aluminium producers, however, is not the relative level of LME basis price and premium. That is a problem for aluminium product manufacturers, which face a systemic risk management dilemma as to how to hedge the premium.
The real issue for producers is the low price of what they produce, even with physical premium added.
And that is down to years of historic overproduction and resulting stocks overhang.
The latter has been absorbed by financiers and will continue to be so as long as a low interest rate environment makes it a profitable trade. Whether they finance the metal in an LME warehouse or a non-LME warehouse is of secondary relevance.
The Damocles sword hanging over Rusal, Alcoa and every other aluminium producer remains that the stocks financing trade will not last forever.
At some stage a lot of metal will come back to the market. And then the "all-in" price of aluminium is, in all probability, going to fall further, whatever the relative composition of LME basis price and physical premium.
At best Rusal has bought itself some time, even assuming a linear link between LME load-out queue and physical premium, something that is increasingly questionable after premiums went supernova at the start of 2014.
Nor are there likely to be many cheers from the warehouse operators themselves.
The LME warehousing landscape has already changed a lot since the LME's consultation process.
Of the original five affected warehouse locations originally identified by the LME, only two are still queue-bound.
The dominant warehouse operator at Antwerp, NEMS, now rebranded Impala Terminals by its owner Trafigura, gave up on the queue game some time ago. There are now fewer than 150,000 tonnes of metal stored in the Belgian port.
In Johor, Malaysia, the copper queue has dwindled to just 25,350 tonnes, probably reflecting the mass movement of material to bonded warehouses in Shanghai.
In New Orleans, the zinc queue has also shortened in apparent reaction to the recent front-date tightness in the LME contract. Much of what was queuing to get out has been put back on warrant. Cancelled tonnage of 96,075 tonnes represents a nominal load-out queue of 38 days, already below the 50-day threshold targeted by the LME's original proposal.
That leaves just Detroit and the Dutch port of Vlissingen, both of which still have long, long queues of aluminium awaiting load-out.
But in both cases dominant operators Metro, owned by Goldman Sachs, and Pacorini, owned by Glencore, have already reacted to the LME's proposal by slashing inflow rates.
Might they start building queues again?
It seems unlikely.
The other weapons in the LME's arsenal are unaffected by the High Court ruling. Those include enhanced powers to query operators on renewed queue formation.
Warehouse operators looking to restart the old queue game can expect a lot of regulatory scrutiny, not just from the LME but from Britain's Financial Conduct Authority, which gave its explicit backing to the LME's proposal.
Moreover, warehouse operators, already fretting about the implications of the LME's root-and-branch logistics review of its warehousing system, are likely to face heightened operational uncertainty as the debate inevitably returns to core drivers of their revenue model.
Which is a smidgeon of good news for the LME itself in all this.
The load-in/load-out rate formula was only ever intended to be a short-term fix for the immediate problem of long queues.
A much bigger overhaul of the exchange's warehouse system, led by the returning LME warehousing tsar Phillip Crowson, was always coming. And that hasn't been changed by the ruling. Indeed, the legal review, focusing on whether the LME can cap rents and load-out charges, has probably just taken on new urgency.
Yet this legal intervention marks an important moment for the venerable exchange.
Rusal's action was unprecedented in terms of a market user using the courts to challenge and overturn an LME rule change.
In the "old" LME, disputes used to be sorted out behind closed doors. The gentleman's club rules dictated that even the aggrieved would accept the finality of the LME's decision.
There is no "old" LME anymore and the old club rules are evidently going with it.
Rusal has just set a dangerous precedent. Now, if members or users don't like an LME rule change, they can just go to court and ask a judge to overrule it.
That's not good news for the LME. And it's hard to see how it's good news for the metal markets in general, least of all aluminium.
But then legal precedent may be the least of the aluminium market's immediate problems. (Editing by Dale Hudson)